Programs issue too many miles. There aren’t enough award seats, especially with planes flying full. They need to either increase the number of award seats or increase the cost of each seat, otherwise you just have frustrated members who can’t redeem.
At the same time programs don’t need to spend as much marketing to fill planes when planes are already full. But that’s an argument for reduced earning, not for changing redemption prices.
Programs with set award prices (award charts) usually devalue in a predictable way.
Fifteen years ago on Flyertalk I outlined a simple model of why we can expect frequent flyer programs to devalue over time.
I explained that frequent flyer miles are a currency, but they are printed by a single company and there’s no independent central bank or other body whose job it is to defend the value of that currency.
When programs ‘print miles’ but the number of redemptions available doesn’t increase proportionally, prices will have to rise.
Milton Friedman…showed the world that inflation is a monetary phenomenon — increase the supply of money in the economy, and the general price level will rise.
The famous and deceptively simple formulation of this is: mv = pq
m = quantity of money
v = the speed at which money circulates in the economy
p = general price level
q = quantity of goodsFriedman argued that the speed at which money circulates is, generally speaking, constant. Folks plan over time for their spending needs. On the whole, if people get paid on Friday they don’t spend all their money on Saturday but spread the spending out until their next payday. (Obviously this isn’t universally true, but on a macro level it winds up being true.)
The upshot of this famous formulation is that when m goes up, p or q needs to go up. If the quantity of goods remains constant (q), that means that p (price) must rise and you have inflation.
I think that this simple formulation is helpful in thinking about loyalty programs.
If m = miles, v = the speed at which folks redeem awards, p = the price of awards, and q = the supply of available award seats, then…
Sometimes the speed at which awards are redeemed goes up. For instance, when loyalty program members are uncertain about the future of their points. There is a common belief that when United declared bankruptcy, there was a ‘run on awards’ — people believing that they needed to cash in now while the airline and the loyalty program was still around.
But on the whole, the fact that 8% or so of seats go to award redemption (over time and across programs) suggests that v is usually stable.
That means that if m — the quantity of miles or points — goes up, then one of two things has to happen:
Either the quantity of award seats have to become more available, or the price of awards has to go up. Otherwise there will be a shortage.
…And since it’s so much easier to accumulate miles than at any time in the past — as programs sell miles to all comers, and miles have become such a popular phenomenon and useful marketing tool — the quantity of miles is ever increasing. It’s profitable to the airlines to sell miles.
That means one of two things happens:
* The quantity of award seats goes up
* The price of awards goes up
I said that means we’re going to see devaluations. And we have, in fairly predictable patterns.
They don’t really happen during recessions (to a large extent only Hilton devalued during the Great Recession), and not just because you don’t want to anger customers when few people are buying your product. Seats and rooms are empty so there’s not a ton of pressure on your inventory. Prices of that inventory are down. But when the economy comes back and seats and rooms fill up, inflationary pressures return.
Here’s the most common reasons that programs find themselves devaluing:
- Sometimes a new program starts, and the people who designed it didn’t know what they were doing, didn’t understand how the program would work in practice. They may have been too generous from the start, or they got the rules wrong so members drove up costs in ways they didn’t predict.
- Other times programs have simply been badly managed. They short-sightedly printed too many miles, got themselves in trouble because they printed currency the program just couldn’t cash. (“Too many miles chasing too few seats.”)
- Travel providers also get in trouble, airlines went through bankruptcies, and they turned to their frequent flyer programs to generate business. They printed loads of miles, and predictably devalued. Classic pump and dump scheme. They convince members to buy tickets to earn miles based on a value proposition, and then change the value proposition.
- Other times programs just see everyone else doing it, and they think they can get away with it too. (“Everybody is doing it so why can’t we?”) Put another way, a program executive thinks that their program doesn’t have to be very good, it only has to be a little good and that’s relative to what others are doing.
At first glance you wouldn’t ever expect a revenue-based program to devalue. As fares rise, you earn more points but redemptions cost more points too. It should have built-in balance.
But there are different kinds of revenue-based programs, and even those that shouldn’t devalue do.
- Revenue-based earning and revenue-based redemption should not ever require a devaluation. Those should be continually in balance. And yet Southwest devalues anyway. And devalues again.
- Revenue-based earning and award charts for redemption will require devaluations. Inflation alone will push up airfares, and thus points earned. It’s untenable for the points cost to redeem for flights to remain constant.
We can expect that more outstanding miles without corresponding increase in capacity will mean award inflation. We can expect price inflation to raise the price of awards in a pure revenue-based program.
What we haven’t seen very much of throughout the history of frequent flyer programs is deflation.
That means you’re unlikely to see your miles worth more in the future than they are today. You should burn your miles now, and then earn more. The key not getting hurt by inflation is to earn and burn in the same period.
I’m surprised Gary “blasts” SW in his comments. Their Rapid Reward program is head and shoulders over their competitors. But it’s costly to Southwest. I believe I’m correct in stating that approx. 14% of SW enplaned passengers are flying compliments of RR.
How good is RR? This week, I booked a non-stop flight between Albany NY and DEN for less than 9,000 RR points. By comparison, try booking any flight on AA for 12,500 points. Good luck with that one!
It’s a point, really, about revenue-based programs rather than Southwest as such..
@ubuguy: “enplaned passengers” according to definition, are revenue passengers only. Nice try, but no prize.
What a great insightful article. Thank you very much.
I disagree about Southwest and I do appreciate their brilliant cancellation fee policies
and free bags
While like any program they do have their sweet spots frequently all they have is
28,000 to 30,000 one way for flights of 2 or 3 hours in their so called wanna fares
I booked a 12,500 miles from a legacy carrier opposed to their 29;000 pints award
Sometimes if I get lucky I’m in First Class over a crappy over priced wanna fare
SW has just as much devaluation as the next airline and high failure rates for finding value approx 70% of the time in my personal attempts to find better value redemptions
in the markets I travel or gift others
Thank you coolhand luke. Would “14% of all passengers flown are non-revenue” be more correct?
Also, dwondermeant …thank you. ALB-DEN is, indeed, a sweet spot with Frontier having recently entered the fray.”
Airlines don’t need to worry about the same factors that go into currency exchange rates, and the ability to exchange points is very limited. So airlines can do whatever they want since there is no competition between points.
“q = the supply of available award seats”. To begin, I think this is really clever analysis which does help one understand miles. Yes, as Economist always say “Ceteris paribus” to analyze a point,this does seem to work. There is only one problem. I see no particular reason that award seats have to limited (ie fixed, constrained, or more or less fixed) in the short run or the long run. In the short run, if revenue received from miles is greater than the the expected cost of redemption on those miles, then the airline can just make more miles available, even in competition with revenue seat miles (which for American Airlines at least, if I read Gary’s previous post correctly, is minimally profitable). Extending this argument over the long run, it would be profitable for the airlines to expand capacity to meet increasing demand due to miles.
Therefore, within the economists world of ceteris paribus this does help us think about increased mileage pricing. In the real world, this situation is more complicated. What do they say about economists: “The First Law of Economists: For every economist, there exists an equal and opposite economist. The Second Law of Economists: They’re both wrong.”
Personally, I think airlines executives think they are printing free money with miles. But if they do not provide an adequate good or service for those miles, eventually the miles will have no buyers. Given the current trajectory of the airlines, I am guessing that happens sooner than later.
Sorry, made big typo:
The passage: “….then the airline can just make more miles available…”
Should read “….then the airline can just make more SEATS available…”
why do AMEX/Chase/Citi tolerate the devaluations of DL/UA/AA miles and continue to buys massive quantities of these miles at the same price as prior to devaluation?
I believe two factors drive the amount of miles outstanding:
1.) Growth of the aviation market. People fly more over time. Even in a mature market such as the US, airline traffic is going up by like 2-3 per cent a year. Everything else equal, an increase in airline traffic means more miles are being issued.
2.) Nowadays, award miles are often tied to the ticket price. Airline ticket prices rise and fall more or less in line with general inflation. Yeah, the previous sentence is a bit of an approximation. Nevertheless, roughly speaking, when inflation of the general price level is, say, 2 per cent, airline ticket prices will go up by roughly 2 per cent as well. But then, the amount of award miles issued/collected goes up by 2 per cent as well (ceteris paribus).
3.) You say increasing participation in award programmes and such is another factor. I don’t believe it is. At least it isn’t in a mature market such as the US.
Now let’s look at the other side of the equation. Airline traffic increasing means airlines offer more flights. That means more award spaces.
Thus, when m on the left side of the equation grows due to factor 1.), so does q grow on the right side of the equation.
But, if m grows due to ticket price inflation, q doesn’t go up. Hence, when there is inflation, people earn more award miles. Everything else equal, that decreases the real price of an award seat.
Hence, if there is inflation/factor 2.) going on, the airline needs to increase p, the price of an award seat, to keep the real value of an award mile (m / p) constant.
I fly Southwest less and earn Southwest points less bevause the value of their points is so limited. I don’t care if flights can be booked for 9k points to Denver if they are less than $150 value. I still consider them if schedule and price work but their loyalty program has little bearing – all things equal I would almost never choose them.
Good analysis – again. The single biggest problem is airline greed. Your last bullet point is true – that revenue based programs with fixed charts CANNOT stay constant because of inflation. TRUE. But the inflation for the cost of an award seat vs the inflation for a revenue seat (see DL where lowest cost for a one way biz class ticket to Europe went from 50,000 to 86,000 in about 4 years) is way out of whack. The cost in points for an award seat FAR exceeds the fare inflation rate. Some would say DL is maximizing profit. I would say it’s greed. DL would much rather sell some of those seats that used to be dedicated for award seats as revenue seats, than to make them available as awards seats. Short term profit thinking. The question is, is this good long term thinking? DL is marching toward making each point worth one cent, which for me, would be an adios to that program and adios to the DL Amex card. If enough people do that, the whole DL frequent flier program can come tumbling down. It would be interesting to know what percentage of DL’s profits come from their ff program. @Gary?
PS to my above comment. The biggest problem here is that there is no “fed” to protect the currency (the points) from inflation. The airlines sell unlimited amounts of points to credit card companies (for money) without setting aside the appropriate number of award seats to keep the currency whole (little to no inflation). If there was a body (the fed) that made the airlines set aside the correct number of seats to keep the points from having run away inflation, the inflation would reflect only revenue ticket price inflation. The airlines love this inflation. It’s part of their profit calculation. They sell the points to credit card companies at 100 cents on the dollar, and then redeem those points later to their customers at much less value. What a great business model as long as you can get away with it.
Good stuff. I walked away from Southwest years ago when they went revenue based. It was a product I didn’t love and put up with to get where I needed in exchange with frequent and simple redemption on a product I didn’t love putting up with cult like loyalist but got me to a domestic vacation spot cheap. Once the devalue hit it is still a good deal but just enough to push me to other airlines.
Programs can devalue or change programs all they want to make it a win for them or maybe even a balance of win/win for the customers and themselves like Southwest has done. One thing that is missing in this is that it is more than about the price or value. To many customers like myself it’s about the mile or the point. If an airline sells me a 5,000 mile ticket for $1,000 and only awards me 1,000 points or 2,500 “miles” it bothers me. I want a value or an equivalent to each mile (or each dollar with hotels). Not some formula. To me and I’m sure others it’s not even about the potential award value it’s about what it represents. It’s like the Ryan Bingham factor “The miles are the point”. When programs mess with this it ruins it a bit in my mind.
@Don in ATL. After quantitative easing (QE), I have never trusted the Fed much. They drove interest rates to near 0%, for over 10 years. Other national banks are worse, driving interest to below 0%. Yuck.
@Other Just Saying, but at least the fed kept the currency in check. Inflation has been insignificant over the past 10 years. Just sayin.
I experienced enough unannounced devaluation and lack of transparency from Delta with respect to their frequent flyer program that I felt they were no longer trustworthy in any aspect of their business, so I stopped flying them altogether..
There should be federal regulations on the issuing of loyalty points which would include how often they can be devalued an by how much they can be devalued. Otherwise, it comes across as fraudulent.
Interesting. As much as I respect Milton Friedman, I’ll offer another explanation. The FF programs are getting flooded with miles from the credit cards. That now accounts for WAY more FF miles than actual flying. Is this because the airlines are run by fools who were unaware this was coming, or because they know what they are doing but believe it won’t “hit the fan” until after they have left? Who knows?
The solution is not to devalue the redemptions, which would be never-ending, but to raise the price the banks are charged to buy those miles. For example – The situation with Southwest seeing a rising % of redemptions. Southwest simply hired a bunch of overpaid idiots to design RR 2.0.
The last thing we need for the airlines is even more regulation. What we need is more competition. FF programs would be a lot better if we still had Northwest, Continental, Virgin America, America West, etc., etc.
As an economist I find this analysis deeply flawed.
1) This economic model simply doesn’t apply to air miles as there is no market discovery mechanism to establish price: it is fixed by the issuer of the currency.
2) The statement that there is no “central bank” for miles is incorrect, as the airline as the issuer is the central bank, just like the Federal Reserve bank issues US dollars. However this central bank is both the issuer of the currency and the price manipulator, and it’s run for the maximization of its own profit as opposed to the benefit of the currency holders.
It is a plain old contract fraud, nothing fancy about it. I give you an IOU today, and when you come back tomorrow to redeem it, I unilaterally tell you that the IOU is worth half as much. Nothing fancy about it; it’s an age-old scam that has nothing to do with economics or monetary policy.
@Ellen you are misreading me, I did not say there is no central bank I said that there is no independent central bank. It’s independence that’s key. The airline issues their own proprietary currency, in whatever quantities it wishes, and can inflate at will. The idea that an economic model doesn’t apply to such a situation is very much inconsistent with the world around us…